December 07, 2017O&G Advocacy Series: What is the ‘Presource Curse’ and what are its Implications for Lebanon?

An interview with David Mihalyi, economic analyst at the Natural Resource Governance Institute and visiting fellow at the Central European University’s School of Public Policy in Budapest

LCPS invited Mr. Mihalyi to Beirut to participate in a conference on economic diversification in resource-dependent countries, which was held on 2 November 2017. We used the opportunity to ask him about the “presource curse” hypothesis and its relevance to Lebanon.

1. We are familiar with the resource curse hypothesis, which predicts negative economic consequences resulting from the discovery and exploitation of natural resources. You recently discussed the “presource curse” in a World Bank paper co-authored with Jim Cust. What is the presource curse and how is it different from the resource curse?
The resource curse has been heavily studied by researchers, who have found that economies dependent on resource revenues tend to have slower economic growth and more social problems in the long run. We instead focused on the short-term impacts of resource discoveries across the globe and were curious to understand how countries fare before production actually begins. We found that following a giant oil or gas discovery, growth systematically underperforms forecasts made by the International Monetary Fund (IMF). For certain countries with weak institutions, the discoveries have even led to significant growth disappointments, compared with pre-discovery trends. We dub this the presource curse.

2. What is the motivation and purpose of your research?
We wanted to better understand a phenomenon we observed when studying Brazil, Ghana, and Mozambique, where oil and gas discoveries were initially followed by rosy expectations, but shortly after led to economic busts. We saw that in many cases, the news of a discovery changed how governments, citizens, and private sector players behaved. In certain cases, it fuelled borrowing, consumption, and government spending. Only a few years later, these countries turned to the IMF for financial assistance. Our research aims to better understand the mechanisms behind this phenomenon and draw some general conclusions.

3. What are your key recommendations to policy makers and financial experts?
Experts should be more cautious about how they make economic projections. One example is project development timelines. Gas projects are notoriously complex to execute, as governments and companies need to overcome myriad regulatory and logistical challenges and interdependent negotiations. It often ends up taking over a decade from a big commercial discovery until production begins in countries with no previous gas finds.
In 2013, the Lebanese Ministry of Energy and Water presented a timeline leading to oil and gas production by 2017/2018, assuming no technical and political delays. With exploration contracts yet to be signed, Lebanon is only marginally closer to production now than it was in 2013.
A survey by Ernst & Young shows that three quarters of oil and gas projects around the world are in fact delayed. To avoid over-optimism, experts need to factor in delays at various steps, as these are the norm, rather than the exception.

4. You warn against excessive focus on savings and sovereign wealth funds at the expense of healthy fiscal management. Lebanon is currently developing a sovereign wealth fund law and the parliament has been debating whether to use oil revenues to repay overwhelming public debt. What would be your advice to Lebanon’s government in this regard?
Accumulating savings abroad through a sovereign wealth fund would likely yield small financial returns in early years. Therefore, earmarking oil and gas revenues for debt reduction should be a priority.
For example, Ghana’s transparent and conservatively managed sovereign wealth funds have yielded a net return of about 1% annually, since they were established in 2011. In the meantime, the government also needs to service very costly debt. It is paying over 8% in interest on its latest Eurobond issuance.
Lebanon has one of the highest levels of debt in the world compared to the size of its economy. This year only, the government issued Eurobonds to the tune of $3 billion at a 7% interest rate. The government needs to find an urgent solution to the country’s debt problem. It should not count on returns from uncertain and distant gas revenues to address these challenges.

5. A major argument in your work is that weak state institutions increase susceptibility to the presource curse. Given the weakness of Lebanon’s institutions, what is the role of civil society organizations and other non-state actors (perhaps the banking sector) in addressing the presource curse?
One important task is managing citizen expectations. The trillions of cubic feet in estimated gas reserves may be misinterpreted as implying vast and immediate wealth for all citizens. But, once accounting for the uncertainties and development, production, and transportation costs, the revenues per citizen may not end up being that impressive. Another important task is scrutinizing the license allocation process and subsequent contracts in order to mitigate the risk of tax avoidance, corruption, and mismanagement, which could prove an even bigger threat to one day realizing benefits from the sector.